Want to improve your firm’s position in the market? Start with your relative performance, write Michael Raynor and Derek Pankratz for Harvard Business Review.
Knowing where your company has been and where it is going is essential for setting the right priorities for the future. Should you be cutting costs or expanding? Pricing up or pricing down? Without understanding the relative dimension of your company’s performance, you could be missing low hanging fruit or chasing an unwinnable goal.
“Relative performance, expressed in percentile rankings, tells you where you have the most room for improvement and sets an upper bound on what is reasonable for you, given how well you’re already performing in comparison with other companies.”
DEFINING YOUR RELATIVE PERFORMANCE
Meaningfully defining your relative performance can be tricky and requires selecting the right comparison group. Beware of the “microscope effect” – whereby the comparison group is too small – and the “telescope effect” – where the sample is too large and varied. In both cases comparison is near meaningless.
The authors have designed a benchmarking tool, which they claim allows CEOs to pit their company data against every publicly listed US company and uses “specialised regressional analysis” to deliver meaningful comparison.
Many companies that appear to be doing well are actually growing at a below-average rate in terms of relative performance. “Their strong absolute results may be blinding them to the significant upside.”
Conversely, companies suffering no or declining growth may actually be performing well for their circumstances when relative performance is analysed. Understanding relative growth can help these companies realise that pursuing better growth is a wasted effort given that they are “already approaching the limits of what is feasible”.
Comparing absolute/relative performance measures can give firms a more objective picture of where priorities lie.
A company with an absolute ROA of 5% and a growth rate of 12% might prioritise improving ROA on the basis of those figures. But when relative performance ranks are taken into account the picture can change dramatically. If the same company’s 5% ROA put it at the 85th percentile for its comparison group and its 12% growth rate at only the 50th percentile, then the priority shifts to strengthening growth.
Focusing on relative performance can bring surprising insight into whether you should be chasing growth or profitability. “Since you can spend a dollar – or an hour of executive time – only once, the choice of which path to pursue can have a significant and lasting impact on a company’s fortunes.”